Soo Boo Cheah explains how the Iran conflict shifted the fixed income landscape almost overnight, moving expectations from rate cuts to potential rate hikes. He walks you through why shorter-maturity, investment-grade corporate bonds are worth your attention right now, why Japan stands out globally after hedging currency risk, and what to expect from the Bank of Canada over the next 12 months. Dan Mitchell explains one of the market's most telling signals: the U.S. dollar, despite strong economic fundamentals, attractive yields, and energy independence, simply isn't rallying the way it should. Dan also shares where he does see opportunity – in resilient emerging market currencies, as well as commodity-exporting G10 currencies, including the Canadian dollar.
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Daniel Mitchell - Managing Director & Senior Portfolio Manager, Global Fixed Income & Currencies
Soo Boo Cheah - Managing Director & Senior Portfolio Manager, Global Fixed Income & Currencies, RBC Global Asset Management (UK) Limited
Where should investors position their currency exposure in 2026?
Daniel: Well, there's been no doubt that 2026 has been a more challenging year for investors. Equity markets are driven by a smaller number of tech companies, bond markets are facing this headwind of higher inflation, and currency markets are facing uncertainty. Traders are torn between the short-term and the long-term implications of this Middle Eastern conflict. In all of these markets, a single headline can suddenly change the investment environment. Whether that's from an employment release, some inflation statistics, or simply a social media post from President Trump. So clearly, a tougher environment, particularly for the DIY investor, and I think what complicates things further for currency traders in particular, is that the U.S. dollar is not behaving as you might expect in our most recent global investment outlook.
We talked a little bit about how the U.S. dollar is usually regarded as a safe haven currency, and how it's times like these, during economic uncertainty and geopolitical stress, that the dollar should be performing much better than it is. And yet, the dollar has really remained largely stable in this tight 5% range throughout the conflict, despite the fact that the U.S. has a lot going for it.
It's got an economy that's performing pretty well, more attractive yields than is available in Europe and Japan, and we have the U.S. being the home to some of the world's most innovative technology companies. Unlike Asia and Europe, the U.S. is also energy independent. So, it's less affected by the war than a lot of other global economies.
It's a telling sign, then, that the U.S. dollar carries all of these positives and still can't manage to rally. We think that reflects an underlying bearishness from investors that are willing to step in and sell rallies, and also recognition that the currency is overvalued and carries a lot of long-term negatives that we've been emphasizing in recent quarters.
It's not that we're particularly bullish on the Euro, the Yen or the British pound, but instead that we see signs of optimism from emerging market currencies. The Renminbi, for instance, is up 6% over the past 12 months, and a number of other emerging market currencies are incredibly resilient in the face of uncertainty. Currencies of Brazil, Mexico, Hungary, South Africa, for instance, have all offered near double digit returns over the past years.
These are countries with strong fundamentals, improving political trajectories, and attractive yields. They would also benefit from a broadly weaker dollar. So, we think if this dynamic continues that these currencies will perform well in the year ahead. And in the same vein, we're also bullish of the more cyclical growth oriented and commodity exporting G10 currencies. That includes the Canadian dollar, which we forecast at 1.30 per dollar in 12 months’ time, and that equates to about a 7% or 8% spot gain over that period.
Given current market conditions, how should investors position bonds?
Soo Boo: Since February, the bond market experienced a sea change. Rising energy prices from the Iran conflict have shifted expectations. Central banks are now expected to raise rates, not cutting anymore. Bond yields are at multi-decade high across developed economies. Some are at the pre global financial crisis level. But here's what matters: higher government bond yields means long-term investors can earn higher income with minimum default risk.
Let's put this in perspective. First, investors have already priced in substantial rate hikes and inflation expectations. The surprise factor is largely gone. This suggests shorter maturity bonds, especially those under five years, having a potential to beat cash return over the next 12 months. Second, AI-related investment. They're driving up with economy activities and optimism about future growth. This is resulting in savers demanding for higher compensation.
We too are expecting bond yield to remain elevated, but we caution that there may not be enough skepticism embedded in growth expectations. A third point, which is higher government bond yield, reflects investors seeking higher risk compensation for rising fiscal spending and debt loads. We believe the steep yield curve in the very long maturity segment largely compensates investors for this risk.
The fourth, and the final point, if the Iran conflict reaches a resolution soon, long maturity bonds return could significantly exceed cash returns. Wrapping up, our strategic views are we prefer short maturity bonds, especially the investment grade corporate bonds. The economic backdrops allow investors to earn extra income from these securities. Regionally, Japan offers the highest yield globally, after hedging away the currency risk, and it is loaded with the most bond risk premium. In Canada, we anticipate
Bank of Canada will raise rates by 50 basis points over the next 12 months, pushing the ten-year bond yield to 3.75%. The bottom line: Government bonds are becoming attractive. You have higher income, and you get global bond market dislocation, presenting meaningful opportunities for investors willing to look beyond the headlines.
